The dollar rowed back from a near-record low against the euro on Monday after the United States unveiled an emergency plan to restore investor confidence in embattled mortgage lenders Fannie Mae and Freddie Mac. The Treasury boosted its direct credit lines to the government-sponsored enterprises (GSE) and said it would buy their shares if necessary.
While the Federal Reserve made its direct lending window to financial firms available to them. The plan went some way to calming market concerns about the health of the US financial and housing sectors, as the two companies fund half of all US mortgages. But analysts urged caution, noting its potential expense.
"This (plan) has opened up a whole new element of uncertainty. Now you are in a much graver situation in terms of the cost of what the US government has been forced into doing," BTM-UFJ currency economist Derek Halpenny said. "There are significant risks and significant uncertainties that could have very, very negative implications for the US dollar," he added.
Underlining the tensions in the sector, federal regulators seized mortgage lender IndyMac Bancorp on Friday in the third largest bank failure in the country's history. By 1115 GMT, the euro was down half a percent on the day at $1.5857, having earlier come within half a cent of April's record highs of $1.6018. The dollar index, which tracks its progress against a basket of six major currencies, added 0.6 percent to 72.210, bouncing off a 2-1/2 month low set before the US announcement. The greenback was also up 0.4 percent at 106.67 yen.
Analysts said the dollar's recovery would depend on whether the US initiatives were enough to calm investors' concerns about the financial health of Fannie and Freddie. Any improvement in their credit spreads and shares may help the dollar rebound further.
Russia's central bank said over the weekend it was happy with its holdings of roughly $100 billion of agency bonds, but other central banks stayed mum. As of mid-2007, China and Japan were the biggest long-term agency bondholders at $376 billion and $228 billion respectively, according to US Treasury data.
Investors will also be watching to see how the latest developments affect Fed Chairman Ben Bernanke's views on monetary policy and the economic outlook. Bernanke will testify before the Senate Banking Committee on Tuesday and the House of Representatives' Committee on Financial Services on Wednesday.
"The (GSE rescue plan) news does nothing to calm fears on the extent of the unfolding economic slowdown and will raise speculation Bernanke will be unable to toe the hawkish line he might have wished to in this week's key semi-annual testimony," said Commerzbank Corporates & Markets.
Money markets have scaled back their expectations for monetary tightening from the Federal Reserve and now don't expect it to start hiking until the autumn. That is potentially bearish for the dollar given the European Central Bank's rate rise to 4.25 percent this month.
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